Since I don't have US Passport yet, and I don't know how legal internet gambling is, I won't pursue the following strategy, but, out of curiosity, where do I make a mistake?

I noticed that you can sell contract against Obama on Betfair.com at a rate 1.44/1 (i.e., you pocket $1,000 and create liability in Obama wins at $1440) with a reasonable depth (when I looked at it, you could enter more than $3,600 worth of such contracts). BTW, that rate implies almost 70% of Obama victory.

At the same time, Intrade prices on Obama are around 63%. I believe if I bought $1,000 of Obama contracts, based on the depth I'd probably pay an average price of 63.5%

So here is my strategy:

Sell $1,000 against Obama on Betfair, and immediately hedge the potential payout by buying $1440 worth of Obama contracts at the price of $1440*0.635 = $914.40

So, right now, I pocket $1,000-$914.40 = $85.60

I also know Betfair takes 5% of the profits, while Intrade charges a very small fixed monthly fee, but no profit cuts (I think it's $20, but I'll consider it a sunk cost of being on Intrade, and probably trading like crazy).

If Obama wins:I make loss with Betfair (so no payment to them), and I pay the BEtfair counterparty with my $1440 I won on Intrade. I keep the 85.60 I made todayIf Romney wins:I make $1,000 profit with Betfair, they take 5% ($50), I am thus left with $85.60-$50 = $35.60

Either way, I make a pretax return between 8.56% (if Obama wins) and 3.56% (if Romney wins) - risk free, instantaneously. With the possibility of repeating, until the both prices converge. Even if I have to keep my money deposited, that market will close very soon, with elections 1 week away.

Now, I would think that in terms of taxes on winnings, I pay the taxes on the NET profits (profits - losses), i.e. I'd be taxing either $85.60 or $35.60.

Where did I make a mistake? (Otherwise I see no reason why people would not do this already.)

I'd say it's EXACTLY the opposite. Granted, you'd have to open and fund two investment accounts (but you'd have to do exactly the same if you wanted in invest in stocks, bonds..). After that, each transaction would be like 4 clicks, and you cound execute both well under 1 minute.

No, the beauty of the strategy (called "arbitrage" in finance) is that you end up with positive (sure) profits regardless who wins. As I wrote above, if Romney wins:

1) My Obama contracts on Intrade will go worthless, but2) I'll still keep the $1,000 from the SALE of Obama contracts on Betfair, and will have no obligation to pay anything to whomever bough the contract on Betfair from me.

Ultimately, in case Romney wins, whenever the winner is certified, I'll have$1,000 from the sale, less 5%*1,000 (Betfair's cut from all the winnings), less 914.40 (what I spent on Obama's contracts on Intrade) = $36.60 sure profit

Edit: BTW, the "arbitrage" strategy is no rocket science. What we are doing is simply selling the relative overpriced Obama contracts on Betfair (odds 1.44 imply 69.44% chance of Obama victory - so you have to pay a lot to get little), while simultaneously buying the relatively underpriced (at 63.5%) contracts on Intrade.

Note that in the real world, very few "arbitrage" opportunities should exist. Even in our case, we can be profitable only temporarily - our sells on Betfair would drive Obama value down, whiile our buys on Intrade would drive the Obama value up - precisely until the contract values would be equal in both markets.

Update: If you thought that with the elections coming, the spread between Betfair and Intrade would shrink - you'd be wrong. As I am writing this, you can sell - up to $90,000 !!!! - worth of Obama contracts at 1.33 odds (corresponds to 75.2% victory). Meanwhile, you can buy Obama victory on Intrade for as low as 65.7% (and all together, about 2,000 contracts are available under 67% ). The 8+% difference is incredible.... Even factoring that buying Obama would cost more and more, I think it's very possible that if you sat in Europe (and were allowed to use Internet gaming sites), you could probably make 5% return in less than 2 weeks on at least $10,000 investment.